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Why It Matters How We Define ‘Insurance’

One seemingly simple question is central to the debate over Republicans’ plan to replace Obamacare: What is insurance?

Republicans want to strip out the regulations in Obamacare that require some people—primarily the young, male and healthy–to pay more so that others–mostly the elderly, female and sick–pay less. Critics say Republicans don’t seem to understand that insurance means some people subsidize others.

In fact, it depends on what you mean by insurance. The basic idea is that a community pools its resources to compensate individuals who suffer some peril such as sickness, death or fire. Pure insurance covers only random perils. Predictable perils generally require higher premiums. Teenagers and people with speeding tickets have more accidents, so insurers charge them more. If they were forced to charge risky and safe drivers the same amount, the latter would then be subsidizing the former.

Over time, though, society has ​increasingly blended subsidies with insurance. Social Security, for example, effectively requires ​younger, ​affluent, able-bodied workers ​and two-earner couples ​to subsidize ​older, less affluent and disabled​ workers and one-earner couples.​​​ ​​The system survives because no one can opt out and there is broad political support for insuring everyone against poverty in old age.

While every other developed country treats health insurance like Social Security rather than car insurance, the U.S. has a hybrid. If you’re poor or old, you get Medicaid and Medicare and the federal government subsidizes both so that the sick don’t pay higher premiums than the healthy. Large employers are similar: premiums don’t vary according to employees’ health status. The company and taxpayer, via the tax break for insurance, subsidize the sick employees.

For individuals not covered by the government or an employer, pre-Obamacare health insurance was more like car insurance. Insurers could charge more to those they expected to cost more: women, the elderly, those with pre-existing conditions, with the result that many of these people went without insurance.

Obamacare tackled this by expanding Medicaid and offering direct income-linked subsidies and by limiting insurers’ ability to underwrite: They could not charge the elderly more than three times the young, charge women more than men, or exclude pre-existing conditions. They had to include essential benefits such as maternity care. This effectively meant some people, such as young men who weren’t about to get prostate cancer or become pregnant, paid more than their risks entailed. To ensure they still bought insurance, Obamacare imposed a penalty if they didn’t.

This cross-subsidization is how Obamacare expanded coverage. But because ​​it inherent​ly​ incentiv​iz​es ​the sick to buy coverage and the healthy not to, it has made it difficult for insurers to profit.

Conservative Obamacare opponents fall into two camps. One opposes the principle of subsidies, either direct or indirect via regulations and mandates​, and are relatively indifferent to swelling the ranks of the uninsured. The other ​wants to reduce the uninsured, but without distorting the structure of the private market that forces some people to overpay so that others can underpay.

This second group would scrap many of Obamacare’s underwriting restrictions, which would stabilize the market by allowing insurers to charge premiums commensurate with risk. Those who couldn’t afford coverage because of gender, age or other risk factors would receive refundable tax credits.

It would still be possible to impose some underwriting restrictions. States routinely impose such restrictions: For example, some prohibit the use of credit scores in determining homeowner-insurance ​premiums. Civil-rights legislation already prohibits charging some customers more because of race.

Avik Roy, president of the conservative Foundation for Research on Equal Opportunity, says age explains 75% of the variation in health risks. Thus, insurers could still be prohibited from excluding pre-existing conditions for members or charging women more than men. So long as they could underwrite based on age, and so long as patients maintained continuous coverage (rather than buying it only when they got sick), insurers could still price coverage profitably.

The Republicans’ original American Health Care Act includes many of these features: it neuters the mandate to buy insurance, penalizes people who didn’t maintain continuous coverage, allows insurers to charge the elderly up to five times more than the young, prohibits exclusion of pre-existing conditions, and offers refundable tax credits that rise with age.

Yet it is also seriously flawed because the age-based tax credits are too small. After 2019, a 60-year-old making $25,000 would receive a maximum credit of $4,000. But as Mr. Roy writes in The Wall Street Journal, premiums for such a person are typically $13,000 and out-of-pocket costs are often unaffordable. The only realistic fix is to spend more. Mr. Roy recommends maintaining the law’s more generous transitional tax credits now slated to end in 2019, which would boost that subsidy to $10,900.

That would cost a bundle, which is one reason President Barack Obama never pursued it. “The revenue/subsidies required to make it work are massive—because they have to substitute for all the complex cross-subsidies,” says Peter Orszag, Mr. Obama’s first budget director.

He also says the AHCA’s effort to require continuous coverage by penalizing those who wait to sign up “doesn’t work.”​ If the penalty were actually effective, it would be much the same as the existing mandate. If it weren’t, people would still game the system. ​

The House plan will move individual health insurance closer to car insurance: Profitable but smaller, with many people without coverage. And the U.S. will, once again, be caught between two different visions of what insurance means.

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